Brokerage analysis of the December quarter show that smaller companies outpaced their larger peers across revenue growth, profitability and cash flow metrics — a reversal that market participants say could mark the start of a broader recovery in the segment.
“Most sectors saw acceleration with smallcaps being the clear outperformer. Earnings downgrades are moderating and upgrades should begin soon,” IIFL Capital said in its Q3 review. The brokerage reiterated its January outlook that 2026 should see earnings upgrades, expects largecaps to deliver 15%+ returns from current levels, and sees smallcaps outperforming over the full year, albeit with a lag.
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Earnings momentum has improved over the past two quarters. Vikas Khemani, Founder of Carnelian Asset Management and Advisors, said earnings have been better sequentially and broadly in line with expectations, particularly in the small and midcap space. “By and large earnings have been in line with the expectations and we think this momentum will continue,” the market veteran told ET Now.
Khemani also pointed out that risk-reward currently looks attractive and that his funds are finding more bottom-up opportunities in the space. For sectors, he added that chemicals, auto and auto components, building materials and parts of consumer discretionary could stand out. In chemicals, he cited potential macro tailwinds following policy changes in China and India after a prolonged period of pain lasting one to two years.
The change in tone has also been visible in how markets are reacting to earnings. Sorbh Gupta, Head – Equity at Bajaj Finserv Asset Management Limited, said the improvement in the smallcap outlook post Q3 is being driven by an alignment between earnings delivery and market sentiment.“While earnings growth in the small and mid-cap space was already improving, stock prices had not reflected this because of persistent negative sentiment, especially around global trade and tariff-related uncertainties,” Gupta said. With the recent US trade deal and improving visibility on capital flows, that gap is narrowing. “We believe stock price movements should increasingly track earnings growth, and in some cases even exceed it through selective valuation re-rating,” he added.
Veteran investor Ashish Kacholia struck a similarly optimistic note following the breakthrough India-US trade deal. In a social media post last week, he said the biggest buying opportunities usually emerge when investors are paralysed by fear, suggesting that the long and painful bear phase in smallcap stocks may have ended. “Looks like the bear market in small caps has officially ended with Donald Trump’s tweet signing the trade deal with India,” he wrote, underscoring the sharp shift in sentiment after months of relentless selling pressure.
Markets appeared to echo that optimism. Indian equities, bonds and the rupee rallied after the US cut tariffs on Indian goods to 18% from 50%, removing what investors had described as the single biggest overhang on Indian assets. Analysts said smallcaps, which bore the brunt of foreign selling and risk aversion, stand to benefit if global flows stabilise or reverse.
Guess what? Early signs suggest that this may already be playing out. Foreign institutional investors (FIIs) have turned net buyers in seven of the first 9 sessions of February, indicating a gradual return of risk appetite.
Further, the prolonged correction that started in September 2024, has also reset valuations. Analysts estimate that over a third of the smallcap universe, representing nearly Rs 16 lakh crore in market capitalisation, is now trading at fair or even undervalued levels.
Arjun Guha Thakurta of Anand Rathi Wealth said the recent selloff created a disconnect between stock prices and business performance. While many smallcap stocks corrected sharply, earnings growth in the segment remained reasonably healthy. He noted that much of the selling pressure stemmed from negative sentiment, foreign outflows and risk aversion rather than a collapse in fundamentals. With foreign investors having largely exited speculative positions, he said the supply overhang appears to be easing.
For now, the over 6% rise in the Nifty Smallcap 100 in February signals a tentative shift in mood. With Q3 earnings delivering on expectations, tariff uncertainty easing and valuations cooling off after a year of pain, market participants say the pieces are beginning to align. Whether the recovery sustains in the coming months remains to be seen, but for the first time in over a year, smallcap investors have reasons beyond hope to stay constructive.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)